Peter Radford / Economics / business investment, consumer confidence, consumption, exports, federal spending, GDP, imports, inventories, non-residential investment, recession, recovery, residential investment, state budgets, state spending, stimulus /

Real Growth, Good Growth

April 30, 2010

We have been waiting all week for the first quarter GDP numbers to be released, and the general expectation was that they would show growth of between 3.0% and 3.5% at annual rates.

Well, the report cam in exactly as predicted: 3.2%.

So the more important question is whether the growth is sustainable, or whether it came from one time sources. Here’s the breakdown:

Consumption contributed 2.6% to GDP
Investment, including inventories, added 1.6%
Net Exports [Exports minus Imports] reduced GDP by 0.6%
Government spending declined and so reduced GDP by 0.4%

So the good news, and it is really good news, is that the core of first quarter growth cam from personal consumption. This is important because it will be consumption that drives the recovery. The jump in consumption was the sharpest for three years and this report came only days after we read that consumer confidence had also risen sharply recently. Couple these two facts together and it is much more easy to predict a sustainable growth rate in the 2.0% to 3.0% range all year.

As for the other aspects of the report:

The pick up in investment comprised mostly a continuation of the inventory adjustment that has been a feature of growth for three quarters now. Given that businesses have been re-stocking for almost nine months now I doubt that inventory adjustments can continue to provide much help to the economy as we get further into the summer months. That leaves business investment and residential investment as the two parts of the overall investment category we need to focus on. In the first quarter business investment picked up quite well and looks set for a decent year. The problem is that the long term issues in residential investment – due to the enormous mess created by the housing bubble – will probably offset and gains elsewhere. So I think that, over the year as a whole, investment will have trouble providing the economy much of a boost.

The trade position always ebbs and flows during a recovery. Usually as the US picks up steam it sucks in oil imports and that hammers GDP . We seem set for a repeat of that cycle this year, so I expect imports to reduce GDP quite a bit as the recovery builds. What could be different this time is on the export side. Our issue continues to be the dollar and its value being too high to enable aggressive pricing by exporters. The turmoil in Europe surrounding the Euro could make the dollar move in the wrong direction – up instead of down – which would then cause our exports to falter. The recent announcement by China that they will allow their currency to float upwards somewhat will mitigate some of this, but, overall, I see net exports being a steady negative all year.

Which brings us to the government spending category.

The really important story here is that total government spending acted as a break on growth. This may appear odd given the enormous efforts being made at the Federal level to provide stimulus. The problem, and it is a huge problem, is that at the state level governments are cutting back furiously to reach more balanced budgets. In the first quarter this state level effort completely wiped out the benefit of the Federal stimulus. In fact it more than offset that stimulus. So we arrived at the bizarre situation where total government spending contracted during the quarter, therefore damaging growth.

While we all can sympathize with states as they struggle to get their budgets sorted out, we should all be very wary of the huge break on growth that this balancing represents. If it is continued at its first quarter pace throughout the entire year – and it may well accelerate – then it will undo much of the good work being done elsewhere.

Frankly many of the states in trouble are getting their comeuppance after years of neglect and voter opposition to sound fiscal management. The aversion to taxes that permeates the nation led many states to resort to trickery, sometimes outright robbery, in order to pay for the services that the electorate still wanted. This obstruction by opponents of fiscal rectitude often came from the more conservative side of local politics where any tax was viewed as a terrible thing. No one, however, wanted to cut services – education, police, firefighting and so on all were allowed to continue at old levels, with the funding increasingly provided by unsustainable accounting tricks. Now the game has ended and voters will have to swallow the consequences of having been coddled all these years. Most of our states are facing huge budget problems that will stretch well into the future. So at the state level, fiscal restraint, will hamper national GDP growth for quite a while.

From an overall perspective, therefore, the GDP report is a mixed bag and contains some pieces that we will need to be concerned about as the year progresses.

Meanwhile, that headline should be the return of consumption as the driver of growth. If that level of activity is maintained throughout the year not only is the economy firmly on a growth path, but it is on a fairly strong growth path.

And that is obviously good news.